Gilts Advance as BOE Minutes Damp Bets of Imminent Rate Increase

Lucy Meakin

June 18, 2014 — 11:20 AM EDT

U.K. government bonds advanced for the first time in five days as minutes of the Bank of England’s June 4-5 meeting showed no policy makers voted to raise the benchmark interest rate from a record low.

Two-year gilt yields dropped from near the highest level since 2011 as investors pared bets the U.K. central bank is moving closer to increasing its key rate from 0.5 percent, where it has been since March 2009. Benchmark 10-year yields declined the most in three weeks. December short-sterling futures contracts climbed the most in a month. The pound fell from near a five-year high versus the dollar before the Federal Reserve meets today.

“Most people had moved to the bank was definitely going to raise rates by the end of the year, or possibly a little earlier,” said Anthony O’Brien, a fixed-income strategist at Morgan Stanley in London. “Today has just taken the heat out of that. Short sterling seems to be a little bit more perky and that’s fed through to gilts.”

The two-year yield fell three basis points, or 0.03 percentage point, to 0.88 percent at 4:18 p.m. London time, the biggest slide in three weeks. The rate rose to 0.93 percent yesterday, the highest since June 1, 2011. The 2 percent gilt due in January 2016 rose 0.05, or 50 pence per 1,000-pound ($1,694) face amount, to 101.765. The 10-year yield slid four basis points to 2.74 percent, the steepest decline since May 28.

Rate Outlook

Gilts tumbled and the pound climbed to the highest level in almost five years versus the dollar earlier this week after BOE Governor Mark Carney fueled speculation by saying in a June 12 speech that the first rate increase “could happen sooner than markets currently expect.”

The minutes of this month’s Bank of England Monetary Policy Committee meeting, published today, said the economy could maintain its pace of growth, and slack “would be absorbed more quickly than had previously been expected.”

“In that context, the relatively low probability attached to a bank rate increase this year implied by some financial market prices was somewhat surprising,” the BOE said.

Forward contracts based on the sterling overnight interbank average, or Sonia, show investors are betting the benchmark rate will increase 25 basis points by February, versus May before Carney’s speech last week. BOE officials last increased borrowing costs in July 2007.

The implied yield on short-sterling contracts expiring in December, which allow investors to bet on the interbank lending rate, fell four basis points to 0.89 percent, the steepest drop since May 14.

MPC Insight

Spare capacity in the U.K. economy could be as little as 0.33 percent of gross domestic product and unemployment may fall faster than BOE officials think, pointing to a “need for a policy profile tighter than in our May forecast,” policy maker Martin Weale said in a speech in Belfast, Northern Ireland, today.

MPC member designate Kristin Forbes said the main challenge over the next three years will be “the process of normalizing monetary policy without undermining the current recovery.” She made the comments to the U.K. Parliament’s Treasury Committee in London.

Some more insight on individual MPC members’ thinking may be revealed later today, when Andrew Haldane delivers a speech in Scarborough, England.

A report yesterday showed Britain’s inflation rate fell to the lowest in 4 1/2 years in May. Consumer prices rose 1.5 percent, the least since October 2009, the Office for National Statistics said. Inflation has been at or below the BOE’s 2 percent target for six months, the longest stretch since 2009.

Complicating Factor

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“The complicating factor is the CPI data yesterday,” said Jane Foley, a senior currency strategist at Rabobank International in London. “There will still be many economists who still think the bank will ultimately be deterred from a rate hike this year. Looking at cable it very much depends what the Fed do. If they announce more of a hawkish trajectory this afternoon you could see cable coming right down again,” she said, referring to the pound-dollar exchange rate.

The pound slipped 0.1 percent to $1.6943 after rising to $1.7011 on June 16, the highest since Aug. 6, 2009. Sterling weakened 0.3 percent to 80.11 pence per euro after appreciating to 79.59 pence on June 16, the strongest since Oct. 1, 2012.

The pound strengthened 9.3 percent in the past year, the best performer after New Zealand’s dollar among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. The euro gained 1.5 percent, while the dollar was little changed.

Gilts returned 2.8 percent this year through yesterday, according to Bloomberg World Bond Indexes. Treasuries earned 2.6 percent and German securities gained 3.9 percent.